Prepping for shareholder activism can help tech companies create value

Shareholder activism is a fact of corporate life. By understanding the trends and being prepared, companies can stay ahead of the critics.

In brief

• As the global economy slows, technology companies will likely face scrutiny from activist investors, with an increasing focus on operational performance.
• Technology companies need to proactively address ESG issues that shareholder activists might seek to exploit.
• By “thinking like an activist,” technology companies can proactively prepare for activist threats and drive meaningful, long-term value creation.

Many of the high-tech companies once loved by investors for their impressive shareholder returns are struggling these days with weak earnings and a disappointing economic forecast. When downturns occur, everyone’s a critic.

Historically, technology has been the sector most frequently targeted by activist investors. In part, that is because tech companies are victims of their own success, having set expectations in the past for growth that can’t be sustained indefinitely. Now, with information technology stocks declining 27% in 2022, shareholder activists are re-emerging, launching 59 campaigns against tech companies since January 2022. Unfortunately, with geopolitical uncertainty impacting supply chains and inflation and rising interest rates dampening consumer demand, the near-term outlook doesn’t hold promise of improvement.

For tech companies that may come under the activist spotlight, it is essential to understand the trends and prepare.

In the current recessionary environment, activist investors are searching for weaknesses and calling for operational improvements

Investors were drawn to tech in years past by eye-catching returns and significant M&A activity. In technology, where formerly fast-growing subsectors are maturing, activists are targeting companies that struggle to transition out of “growth mode,” challenging business models, scrutinizing portfolios and pushing management to deliver better results. Campaigns are focused on divesting noncore or unprofitable businesses, improving profitability through operational efficiency, and cutting costs or reorganizing the business structure.

Activist value creation demands

Activist investors most frequently focus on M&A as a means of value creation, notwithstanding increasing operational demands. While M&A activity has cooled lately, the comparatively high volume of M&A in the tech sector provides ample opportunities for activists to push their M&A strategy. Most frequently, activists who target companies push for the sale of the company. In several instances, the announcement of an acquisition triggered an activist campaign advocating for a sale of the prospective buyer instead. Activists also assess technology companies’ portfolios to identify assets they believe are more valuable to others and could be targets for divestment.

Tech company leaders must learn to “think like activists” and continually review their portfolios and the long-term value creation potential of all M&A options to generate optimal returns and mitigate activist risks.

While M&A is still the most common focus of campaigns, activists are increasingly demanding operational improvements they believe will create value. In the 12 months through June 2022, calls for operational improvements made up 34% of all activist demands for value creation in the sector, 12 percentage points higher than the prior year and nearly five times higher than in 2017 (See graph above). This trend is expected to continue.

Capital allocation demands have declined in popularity. From 2010 to 2018, approximately 40% of campaign demands focused on capital allocation, compared to less than 6% each year from 2019–2022, according to EY analysis. Activists still incorporate capital allocation demands, but more as a means of achieving strategic goals. For example, Third Point LLC, in a 2020 letter to Disney’s CEO, argued that the company should “permanently suspend its $3 billion annual dividend and redirect this capital entirely into content production and acquisition for Disney’s DTC [direct-to-consumer] businesses, centered around Disney+.”¹

Companies in the technology sector face environmental, social and governance (ESG) pressures that need to be proactively addressed

Governance: Increasing pressure from activist investors to adopt best practices

Technology companies frequently establish governance structures and policies that limit the power of shareholders, such as establishing founder or CEO control, dual-class voting and classified boards. When comparing the Silicon Valley (SV) 150 to the S&P 500, the SV 150 were six times more likely to be founder or CEO controlled, three times more likely to have dual-class voting and 17 times more likely to have a classified board.

Influential institutional investors such as BlackRock, Vanguard and State Street, as well as proxy-voting advisors ISS and Glass Lewis, have made clear their objection to these policies and their willingness to vote against them. At Alphabet’s 2022 annual general meeting, numerous institutional investors voted for a “one share, one vote” recapitalization plan. BlackRock acknowledged the potential benefits of the dual-class structure for newly public companies but said that “these structures should have a specific and limited duration” and that it wanted to send a strong signal “that proportionate voting rights are integral to good governance and accountability.”² We expect the number of governance-related campaigns to increase as more investors prioritize shareholders rights and controlled companies are further scrutinized by shareholders.

Environmental: Growing scrutiny of the full value chain

Technology companies have typically positioned themselves as environmentally friendly and pointed to limited direct (Scope 1) emissions. However, activists are increasingly focusing on the full environmental impacts of the supply chain including using Scope 2 and Scope 3 indirect emissions as potential levers in campaigns. Resource-intensive businesses, such as semiconductor manufacturers and data centers, are especially vulnerable to scrutiny.

Social: Focus on technology’s impact on society

Activist investors increasingly identify social factors as both real risks to be managed and opportunities for value creation. For example, when activist Blue Harbour invested in WebMD, it cited data security and increased gender diversity³ as top priorities. In another example, JANA Partners pushed smartphone manufacturers to provide parents more resources to manage children’s use of devices, arguing this would enhance long-term value for shareholders by creating more choices for customers today and “helping to protect the next generation of leaders, innovators, and customers tomorrow.”⁴

Management and the board can prepare for an activist threat to drive value creation

There are three steps technology companies can take to reduce the risk of activist campaigns by improving value creation — and manage them better when they occur.

1. Develop an activist response plan

A robust response plan is critical to coordinate the company’s initial actions when an activist announces an ownership position. Missteps in the first 24 to 48 hours, particularly when the activist is adversarial from the start, can be costly.

An activist response plan must include:

• Clearly defined roles and responsibilities for senior management, the board and external advisors
• Explicit rules of engagement and detailed procedures for how to react to common activist tactics, including an established chain of command for information flow and decision-making
• Robust frameworks for managing any engagement with the activist, evaluating the need for a public response and potential strategies if warranted, and determining how best to engage with stakeholders and solidify support from key constituencies

2. Regularly prepare for potential shareholder activist engagement

Executives and board directors can strengthen their ability to counter an activist investor threat by actively preparing as a group. Best preparation practices include:

• Keeping current on shareholder activism trends, including common activist strategies, and knowing about the most engaged activist funds and their preferred tactics
• Conducting an “activist simulation” exercise that reflects the typical speed and escalation of a live activist attack and emphasizes individual responsibilities, rules of engagement, and the need for strong coordination between management and the board
• Assessing the strength of the relationships with key shareholders and understanding voting patterns of important institutional investors

3. Use a shareholder activist lens to identify value creation opportunities

The best way to get ahead of investor activists is to leave as little room for complaint as possible by producing steady earnings. As hard — or even unrealistic — as that may be, it’s a simple fact that companies that deliver consistent shareholder returns are subject to fewer activist attacks.

A good way to do this is to think like an activist. Leaders can review the company’s performance from a hypothetical activist’s perspective to understand where the vulnerabilities might lie and identify potential value creation opportunities. Questions to ask include:

• What opportunities exist to improve products and customer service to increase top-line growth and profitability?
• Could we redesign our organizational structure to accelerate decision-making and reduce unnecessary administrative costs?
• How can we free up working capital that can be redeployed for growth or strengthen the balance sheet?
• Do we have the right business portfolio for today and the future? Are there opportunities for accretive divestitures?
• How can we streamline the business to be more cost efficient and resilient to revenue fluctuations?
• Do our corporate governance policies reflect industry best practices, promote accountability and align incentives for long-term value creation?

Companies can regularly review activist vulnerabilities, socialize improvement areas with the board and develop robust plans to implement changes to drive long-term value creation. This preparation will help management avoid potential disruptions and negative outcomes if an activist arrives.

Addison Lanier and Rahul Agrawal contributed to this article.